While the Union Budget, presented by finance minister P. Chidambaram, has been welcomed by the private equity industry for its ability to contain fiscal deficit, the industry’s demand for tax pass-through status under the new AIF (Alternative Investment Funds) Regulations 2012, met with disappointment. The budget proposes pass-through status only for a sub-section of Category I although the entire category includes venture capital funds, SME funds, social venture funds and infrastructure funds.

However, the budget aims to provide pass-through status only to venture capital funds under Category I, leaving out the SME funds, social venture funds and infrastructure funds. For Category II, which includes general private equity funds and real estate funds, and Category III, which includes hedge funds, this exemption has not been allowed either.

“The big disappointment in the budget is that the finance minister could have taken a much more liberal view of AIFs because there is a very nuanced difference between Category I and Category II. Many of the funds do both investments,” said Gopal Srinivasan, founder and chairman of TVS Capital Funds.

“The industry was expecting more clarity and certainty around tax pass-through for all categories of AIF. That not only continues to remain elusive but by narrowing down the exemption under Section 10 (23FB) to only the sub-category of VCFs, this has also made all other sub-categories of Category I AIFs viz. infrastructure funds, social venture funds and SME funds ineligible for the pass-through tax treatment. Considering that these sub-categories were viewed as those ‘which have a positive spill-over effect’ on the economy, it would have been more appropriate to have included them for the specific tax pass-through treatment,” said Siddharth Shah, Partner at Khaitan & Co.

To put this in context, the PE/VC industry had been lobbying for tax pass-through status across all sectors (as against the selected ones like biotechnology and nanotechnology) for years. In last year’s budget when VCF regulations were still in play, this tax exemption was granted to all sectors. But the market regulator SEBI implemented the AIF regulations later in 2012 and that created ambiguity regarding the pass-through status.

“Also, it would have been great to have AIFs permitted in the investment list of pension funds and charitable institutions,” added Srinivasan whose TVS Capital manages over Rs 1,000 crore in rupee private equity funds.

Fiscal consolidation welcomed

The industry has, however, welcomed the budget from a macro perspective although more clarity is needed. “I think the budget has come out well as there had been a lot of negative expectations from it about increased taxation – both direct and indirect. The biggest positive is that the finance minister has been able to contain the fiscal deficit at 5.2 per cent. The plan to reach to 4.8 per cent needs to be examined in terms of where the government aims to get the money from,” said Jayanta Banerjee, CEO of ASK Pravi Capital.

“Overall, the budget lays a clear road map towards growth and fiscal consolidation. We need to wait and watch whether the plans are turned into reality through strong execution and impeccable governance,” said Srinivasan.

Kirti Shah, partner (corporate finance advisory services) at BDO India, said, “The whole objective of the budget is to put the sentiment from negative to neutral. They will wait and watch for one or two months and hold some of the major announcements. But overall, the finance minister wants to encourage FDI by streamlining and making it simpler for the outside world.”

Positive measures for manufacturing, MSME & infrastructure

Measures announced for the manufacturing sector such as the investment allowance of 15 per cent for investment (exceeding Rs 100 crore) in plant & machinery had also been welcomed. Plus there are several provisions for micro, small and medium enterprises (MSME) in the budget which were also appreciated. “The finance minister has incentivised the growth of SMEs by extending the benefits offered to them even three years after outgrowing the SME status. He has also increased the access of capital pools for the MSMEs through additional funding of Rs 5,000 crore to SIDBI,” added Srinivasan.

The budget also addressed several issues in the infrastructure sector. “The budget has a lot of positives, addressing concerns regarding the infrastructure sector. There are talks around pricing gas at the market rate, coal extractions through the PPP route, regulator for the road sector and infrastructure bonds. But I think financial investors taking over 10 per cent stake will now have to go through the FDI route in the infrastructure sector and that may also raise some concerns,” said MK Sinha, CEO of IDFC Alternatives.